Bear markets can be hazardous for growth stock investors. It’s rough to see your stocks drop by 60% or more. The key is diversification and keeping a cash balance. The more cash you keep during good times, the more you’ll have to gobble up growth stocks at low prices during the bad times.
The stocks that we’ll discuss today, Zillow Group (Z 0.59%) (ZG 0.21%) and Innovative Industrial Properties (IIPR 1.27%), have been hit hard this year, down at least 45% year to date (YTD), and they both took close to 20% hits in June. That just means they’re right where we want them.
Growth stocks are inherently volatile. Investors have high expectations for the stock and future revenue , and plenty of shareholders will sell at the first sign of trouble. The way we want to buy them is with dollar-cost averaging, which is essentially buying a small amount of each stock every month. With as little as $135 you could buy a share of each of these stocks.
Zillow is the 800-pound gorilla in the online real estate search space. It had 211 million average monthly users who visited the site a total of 2.6 billion times in the first quarter of 2022. There are 135 million homes in the database, and 4.1 million actual buyers used the site to shop last year. None of that was enough to set a floor under the stock, which is down almost 70% over the last year.
First, the problem was the company’s iBuying fiasco, wherein it attempted to flip houses with a doomed-from-the-start investment arm. Today, the problem is monetizing users.
Of the 4.1 million users who shopped with Zillow in 2021, 1.4 million used a Zillow Premier Agent, and Zillow earned an average of $4,100 per transaction. Zillow management believes it can convert users and earn revenue on not only buyer’s agent referral fees but also mortgages, closing costs, and seller services on each transaction. The total amount it could earn per transaction, based on a $366,400 median home price, is $17,000 — more than four times what it is earning now.
That is certainly a good growth case for Zillow, but demand for real estate has dipped , and we haven’t seen legitimate progress on the user revenue conversion just yet. That’s why averaging in is perfect.
If you would normally make Zillow a 5% position, you can start buying a half of a percent or a quarter of a percent every month. It’s unlikely that the company with a 63% share of daily active users is going away. You can build a position slowly through the rough times, and by the time the stock breaks out, you’ll have a low cost basis.
Innovative Industrial Properties
Innovative Industrial provides real estate leasebacks to cannabis growth facilities. Like Zillow, Innovative Industrial is the big dog and first mover in its industry, growing like a weed (get it?), and has recently stumbled. The stock is down about 60% YTD.
Part of the reason for the drop is the general real estate market weakness, but a lot of it stems from significant issues. One of the real estate investment trust’s (REIT’s) biggest tenants recently defaulted on over $2 million in rent and management fees. If — and that could be a big if — this event ends up being just a speed bump for the REIT, there could be extremely high returns in the future for investors with the stomach to buy now.
Innovative Industrial has grown revenue from $32 million in 2016 to $226 million over the last 12 months. It’s run by an experienced management team that founded the company after working together at a similar niche real estate company. It has grown revenue this fast, despite marijuana being illegal in most states. If marijuana is legalized federally, and all signs point to that inevitability, Innovative Industrial will be the go-to real estate company in the industry, with both the expertise and the connections.
This is another perfect opportunity for averaging in. If something even more calamitous happens, the position should be small enough in your portfolio that you can recover without breaking a sweat. But if the business fulfills its potential over the long run, you’ll have a good position built with low prices.
Mike Price has positions in Innovative Industrial Properties and Zillow Group (C shares). The Motley Fool has positions in and recommends Innovative Industrial Properties, Zillow Group (A shares), and Zillow Group (C shares). The Motley Fool has a disclosure policy.